Leiden Law Blog

The end of COMI as we know it: Insolvency rules in the era of decentralisation

It is a well-established principle in many countries around the globe that the law applicable to insolvency (lex concursus) shall be the law of the jurisdiction where the company has its centre of main interest (COMI). This is where the insolvency proceedings (main insolvency proceedings) should be initiated and conducted. Usually, COMI will coincide with the place of the company’s registration. It will otherwise be found in the place where the debtor conducts the administration of its interests on a regular basis and which is ascertainable by third parties (see e.g. Article 3 of the EIR, recast). This would frequently include considerations of the company’s management operations, location of its human resources or even the domicile of its directors.

The main idea behind introducing the COMI concept is to make sure that insolvency cases are handled in an efficient and predictable fashion, i.e. to prevent parallel bankruptcy proceedings and restructurings, which logically increase transaction costs and may lead to a piecemeal sale of debtor’s assets. It is also in the interests of creditors to be well aware and take into account risks related to their counterparty’s possible insolvency.

The rise of decentralisation

Globalisation was a leading trend at the end of the 20th and beginning of the 21st century (although one might wonder if current political events in the UK and other countries change this trend). Globalisation has been accompanied by increased flows of capital, goods and work-related migration. It is believed though that the anticipated 4th industrial revolution will go even further by changing the way business is carried out on an international scale.

At the core of this change lie modern technological developments, characterised by distributed nature, trustless consensus mechanics and undisputed reliability. The first and by far the most famous example of the latest inventions is Bitcoin, a “cryptocurrency” that operates on a P2P basis, i.e. without an intermediary or central authority such as governments or banks. All transactions between Bitcoin users are verified and validated by other users and recorded in a public distributed ledger (“blockchain”). Despite the fact that the cryptocurrency did not become prominent in retail transactions, Bitcoin has proven to be a good investment asset, and (maybe more importantly) introduced the blockchain technology into the world. Blockchain makes it possible to record multiple transactions in a decentralised and distributed manner so that such transactions cannot be altered retroactively.

Apart from its use for cryptocurrencies, blockchain allowed the creation of the so-called DAOs or decentralised autonomous organisations, which in essence are computer codes that allow people from all over the world with access to the Internet to anonymously enter into series of transactions, which are enforced and recorded on blockchain. They are therefore decentralised (not linked to any particular jurisdiction) and distributed among their users. Without going too far in explaining the technical side of DAOs, it is sufficient to say that they allow a partnership-like ‘entity’ exist, attract new investor-users and make decisions by majority voting of its users (voting rights are shaped by ownership stake).

What about COMI?

A DAO is based on a decentralised model – its members may be unaware of who other members are and which countries they come from. Besides, there is no central authority or management, as decisions are made by DAO’s members themselves by way of voting on proposals – which in turn can be supplied by robo-advisors. Each transaction is kept on the blockchain. Given these characteristics, it becomes especially problematic (if not impossible) to link a DAO to any particular jurisdiction. For instance, one of the first DAOs – The DAO acted as a venture capital vehicle, whose members acquired ownership stakes by spending cryptocurrency called Ether (digital value token of the Ethereum blockchain) on The DAO’s “shares” or tokens. Ether, like Bitcoin can be purchased online from any place without providing any identifying information. The DAO had no physical address, employees or management. Even though the exact legal status of The DAO (or any DAO for that matter), is unclear, whereas risks (both regulatory and operational) remain high, it managed to raise more than USD 100 million in just 2 months since its launch in April 2016. Yet a then unforeseen flaw in The DAO's code was exploited, resulting in a USD 60 million loss and the collapse of the project.

Despite the fact that The DAO’s fate was doomed, its failure did not undermine the prospects for decentralised organisations. In my view, modern technological advancements (i.e. blockchain), allowing trustless decision-making between anonymous persons will play an ever bigger role in the future. And with this rise of decentralisation in mind, it will be more and more difficult to find a linking factor to any single jurisdiction. The conservative criteria formulated for locating COMI, especially the idea that it should be ascertainable by third parties, simply does not fit the new decentralised world paradigm. In decentralised entities, there is no management – decision-making is inherently democratic, there are no physical assets – only digital tokens; such entities do not have offices or officers, while the stakeholders might be scattered around the globe.

Contractualism revived

In light of the abovementioned insurmountable obstacles in locating COMI, a new approach should be promoted. Professor Robert Rasmussen some time ago suggested that each independent corporate entity should be allowed to specify in its corporate charter the jurisdiction that will handle any bankruptcy proceedings involving that entity. This theory, usually referred to as “contractualism”, has been criticised by many for exclusion of interested parties in the decision-making process and the (supposedly) pro-debtor choice of insolvency rules made by shareholders. This criticism, although valid, does not seem to be very persuasive, if we consider the nature and qualities of decentralised entities. Firstly, the activity of venture capital vehicles (such as The DAO) seems to affect third party rights to a lesser extent – it is the investors who can suffer the most. Secondly, other alternatives to finding COMI (e.g. by locating the place of its majority members through IP addresses or other means) will inevitably raise transaction costs and seem counterintuitive.

Instead of agreeing on the COMI in a company’s charter, as suggested by Rasmussen, it should in my opinion be provided for in the form of a code, incorporating governance and decision-making rules. This approach would guarantee sufficient certainty in a fluid, dispersed and cross-border environment in which modern communities operate. Importantly, in order to prevent forum shopping, it is crucial that the COMI part of the code cannot be altered by the collective voting (“frozen spot”).

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